Those Zany Xenophobes

Savoring the triumph of poking a stick in the eye of an upstart Arab country, U.S. lawmakers are girding for a face-off with a much larger opponent. With the rescue of the American seaboard from a shadowy sheikdom now a mission accomplished, they are steadying their aim at the second largest economy in the world – China.

Senators Chuck Schumer and Lindsey Graham are mad at the dragon. China, they claim, keeps its currency – the yuan (or the renminbi) – too low. A low yuan allows China to flood the U.S. with cheap manufactured goods. Those cheap goods are causing job losses, the reasoning goes, ruining whole manufacturing sectors in this country. If China would just appreciate its currency by 40 percent, its goods would be similarly re-priced. A made-in-China $40 bathrobe hiked to $56 might allow those Carolinian textile workers toiling in Sen. Graham's home state to compete with their Asian counterparts.

But China is not too gladdened by the prospect of a sudden currency appreciation against the dollar. It owns dollars – perhaps 600 billion of them – which means that a 40 percent appreciation of the yuan would result in a massive devaluation of its dollar holdings. From China's perspective, a currency rise would cut exports, swell imports, and shrink its reserves dramatically.

Some deal.

So it is doubtful that China would satisfactorily oblige the senators on this issue, responding instead with another feeble loosening of the yuan/dollar trading band. That would force Chuck and Lindsey to go to plan B – slapping a 27.5 percent tariff on Chinese goods.

It is not hard to imagine one immediate consequence of a U.S. tariff imposition on Chinese imports – the flow of Chinese goods would immediately backwash into Europe. A country like Italy for example, battered by a sevenfold increase of Chinese shoe imports between 2004 and 2005, would find its leather goods industry decimated. Protectionist cries, already mounting in the Eurozone, would become deafening. Tariffs or possibly strict import quotas would ensue.

The combined effect of U.S./EU trade sanctions would most certainly deepen the schism between East and West. This schism would ring-fence the Mideast, India, Russia, and China – further entwining them politically and economically. Most probably, it would speed China's hunt for whatever energy deals remain in the contiguous Middle Eastern/Eurasian landmass. Also, it would likely fortify China and its neighbors against U.S. demands to mete out sanctions on Iran for its alleged nuclear ambitions.

Domestically, tariffs would cause a large upturn in unemployment in China, testing a leadership already struggling with significant unrest in rural areas. The ripple effects of this might include the ratcheting-up of its military preparedness and the hardening of its foreign policy stance.

Now, if Sen. Schumer – a New York Democrat – were an honest broker, he'd confess that pulling the tariff card out of the hat is an old Republican trick – one more in keeping with the party philosophy of his Sinophobic partner, Sen.Graham.

In the 70-odd year stretch between Lincoln and Hoover, when all but two presidents hailed from the Grand Old Party, tariffs were the nation's way of supporting big business and keeping wage levels high enough to attract cheap immigrant labor. This halted when Woodrow Wilson, a socially progressive Democrat, lowered tariffs under the Underwood Tariff Act in 1913 and established the first federal income tax to compensate for lost revenue.

Two Republican senators – Smoot and Hawley – resurrected tariffs in the 1930s, writing their eponymous act. Originally intended to stem agricultural imports, it snowballed into a comprehensive curb on foreign goods. Retaliatory measures by other nations triggered a 66 percent collapse in global trade in four years.

But things are far more complicated today: world trade in goods and services is larger than ever, and the U.S. is a debtor nation. Both the government and its citizens rely on foreign financing and the giant dollar-recycling machine to keep them alive.

Cheap financing, in fact, is facilitated by China's pursuit of an explicit policy of dollar-recycling. China takes its dollar-denominated export earnings and buys U.S. securities – such as Treasury bonds – in order to keep a lid on its currency. (Imagine how the renminbi would skyrocket if China sold all of its surplus dollars and bought renminbis.)

If Congress succeeded in passing tariffs, China's capacity to earn dollars would plunge, reducing its role in financing the U.S. budget and trade deficits. The "global savings glut" coined by the new Federal Reserve chairman, Ben Bernanke, would quickly dissipate. Interest rates, kept low by the ubiquitous slosh of dollars, would reverse their 20-year decline. Recent data suggest that this is already occurring.

Given the administration's constant denigration of the Arab world, the recent public alarm over the DP World business deal is somewhat excusable. But will that alarm translate into endorsing the Schumer plan, which could double the price on goods Americans now cart away from Wal-Mart? Or will Americans simply not connect the dots between China-bashing and the consequent spikes in prices, interest rates, and taxes until after the fact – i.e., when they find themselves confronted with a hefty dose of sticker shock on all three fronts?

Schumer, having aroused the xenophobic fears of most Americans, is shamelessly gunning for political points as a born-again flag waver. In reality, he's taking a contemptible potshot against America's most willing banker. The fallout won't be cheap.